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Why you should pay off credit card debt first
Since your credit card likely charges higher interest rates than your car loan, it’s a good idea to pay off your credit card debt first.
Credit cards have variable interest rates. These interest rates shift up and down depending on the prime rate. Currently, the average credit card interest rate is a variable 17.36 percent. Car loans, on the other hand, tend to come with fixed interest rates, which means that whatever interest rate you’re offered at the beginning of your loan remains unchanged for the life of the loan. Auto loan interest rates tend to run about 4 percent.
If you’re running up more interest on your credit card balances than you are on your car loan, it makes sense to pay your credit card debt off as quickly as you can. You don’t want to pay any more in interest than you have to, right?
Here’s one more good reason to pay off your credit card debt first: as you pay off your credit card debt, your credit utilization ratio will go down and your credit score should go up. Credit utilization refers to the amount of credit you are currently using versus the amount of credit available to you, but it only applies to revolving debt like credit cards, not installment debt like car loans.
Believe it or not, having an unpaid car loan on your credit report can actually benefit your credit score. This is because the three credit bureaus (Equifax, Experian, and TransUnion) like to see that you can handle a mix of credit — both revolving debt and installment debt. Making regular car payments while you pay off your credit cards can be a smart move, credit-score-wise.
Plus, some car loans come with a prepayment penalty if you try to pay them off early. That’s another good reason to pay down your credit cards instead of trying to pay off your car loan ahead of schedule.
Why you should pay off car loan first
If your car loan balance is significantly smaller than your credit card debt, it might make sense to pay off your car loan first. That way, you can own your car free and clear while you focus on paying off your credit cards.
Owning your car also makes it easier to sell it or trade it in for a different vehicle. If you’re thinking about swapping your current car for a newer model, paying off your existing car loan first will keep you from having to roll the money you owe on your old car into your new car loan.
If your car loan has a variable interest rate instead of a fixed interest rate, it might be a good idea to get that loan paid off before the interest goes up. But keep in mind, even car loans with variable interest rates are likely to charge less interest than credit cards.
How to choose whether to pay off credit card or car loan
If you don’t know whether to pay off a credit card or a car loan first, Bankrate offers a debt paydown calculator that can help you make an informed decision.
Simply enter the amount of each debt, its interest rate and its minimum monthly payment. Then enter the amount of extra money you can put towards your debt every month and your annual income/tax bracket, and Bankrate’s calculator will tell you which debts to pay off first and how much money you should put towards each debt. If you have multiple credit cards with different interest rates, the calculator will even tell you which card to prioritize.
As you work towards paying down your credit cards and car loan, refer back to this calculator to ensure you’re still on the right track. Keep updating it with your current balances, interest rates and payment plans, and you’ll be able to follow a debt repayment plan optimized just for you.
Alternative options to pay off debt
If you’re hoping to pay off your credit card debt as quickly as possible, a balance transfer credit card can help you consolidate your credit card balances. The best balance transfer credit cards offer between 15 and 21 months of zero percent APR, giving you plenty of time to make a dent in that debt — or pay it off in full.
You might also consider taking out a personal loan and using that money to pay off your credit card debt. Like car loans, personal loans tend to come with lower interest rates than credit cards, making them an excellent debt consolidation option.
If you want to lower the amount of interest you’re paying on your car loan — or simply lower your monthly payment — you can look into refinancing your car loan. You could also transfer your car loan to a credit card, but that option comes with a few risks and might not be the best way of paying off your debt.
The bottom line
In most cases, it is better to put extra debt repayment money towards your credit cards instead of your car loan. Credit cards are more volatile than car loans and usually charge more interest; plus, you’ll probably get a bigger credit score boost when you pay down your credit card balances.
If you only have a little bit of money remaining on your car loan, or if you plan to sell or trade in your car in the near future, it could be smart to pay off your car loan before your credit cards — otherwise, focusing on paying off your credit card debt as quickly as possible is generally the way to go.